INVENTORY MANAGEMENT

OUTLINE

• Need for inventories

• Order quantity – EOQ model

• Order point

• Pricing of raw materials and valuation of stocks

• Monitoring and control of inventories

• Criteria for judging the inventory system

• Inventory management in practice

 NEED FOR INVENTORIES

• ‘Process or movement’ inventories are required because

it takes time to complete a process/operation and to

move products from one stage to another.

• Organisation inventories are maintained to widen the

latitude in planning and scheduling successive

operations.
 ORDER QUANTITY – EOQ MODEL
2FU
Q=
PC

Q = economic order quantity

F = cost per order
U = annual usage/demand
F = cost per order
C = percent carrying cost
P = price per unit
 ORDER POINT

• If the usage rate of materials and the lead time for

procurement are known with certainty, then the
ordering level would simply be:

Lead time in days

x Average daily usage
for procurement

• When the usage rate and lead time are likely to vary, the
reorder level should be:

Normal consumption + Safety stock

 PRICING OF RAW MATERIALS

The important methods of pricing inventories used in

production are:

FIFO (First in First Out) Method The material which is

issued first is priced on the basis of the cost of material
received earliest, so on and so forth.

Weighted Average Cost Method Material issued are

priced at the weighted average cost of materials in stocks
 TREATMENT OF FIXED
MANUFACTURING COSTS

Direct Costing Fixed manufacturing overhead costs are

treated as period costs and not product costs. Hence, they
are not reflected in inventory valuation.

Absorption Costing Fixed manufacturing costs are treated

as product (or inventoriable) costs.
 JUST-IN-TIME (JIT) INVENTORY CONTROL

• The JIT control system implies that the firm should

maintain a minimal level of inventory and rely on
suppliers to provide parts and components ‘just-in-time’
to meet its assembly requirements.

• This may be contrasted with the traditional inventory

management system which calls for maintaining a
healthy level of safety stock to provide a reasonable
protection against uncertainties of consumption and
supply – the traditional system may be referred to as a
“just-in-case” system.
PROGRAMME OF INVENTORY
MONITORING AND CONTROL
• Exercise of vigilance against imbalances of raw materials and
work-in-process which tends to limit the utility of stocks.
• Vigorous efforts to expedite completion of unfinished production
jobs to get them into saleable condition.
• Active disposal of goods that are surplus, obsolete, or unusable.
• Shortening of the production cycle.
• Change in design to maximise the use of standard parts and
components which are available off-the-shelf.
• Strict adherence to production schedules.
• Special pricing to dispose of unusually slow-moving items.
• Evening out of seasonal sales fluctuations to the extent possible.
 ABC system of Inventory
Management
 ABC analysis is an approach for classifying inventory items based on the
items’ consumption values. Consumption value is the total value of an item
consumed over a specified time period, for example a year. The approach
is based on the Pareto principle to help manage what matters and is
applied in this context:
• A items are goods where annual consumption value is the highest. Applying
the Pareto principle (also referred to as the 80/20 rule where 80 percent of
the output is determined by 20 percent of the input), they comprise a
relatively small number of items but have a relatively high consumption
value.
• B items are interclass items. Their consumption values are lower than A
items but higher than C items. A key point of having this interclass group is
to watch items close to A item and C item classes that would alter their
stock management policies if they drift closer to class A or class C. Stock
management is itself a cost.
• C items have the lowest consumption value. This class has a relatively high
proportion of the total number of lines but with relatively low consumption
values.
 Benefits of ABC system
•Better control over high-value inventory improves availability, and reduces
losses and costs.

•More efficient use of stock management resources. For example, during

stock count more resources are dedicated to A class than B or C class
holdings, or fewer counts are made of B or C class holdings – which saves
time and money.

•Relatively low value of B or C class holdings can allow a business to hold

bigger buffer stocks to reduce stock outs.

•Fewer stock outs resulting in improved production efficiency.

•Fewer stock outs and improved production efficiency resulting in more

reliable cycle time and, therefore, improved customer satisfaction.
ABC Analysis

Consumption
Class Items Cumulative
value

A 20% 70% 70%

B 30% 20% 90%

C 50% 10% 100%

 INVENTORY MANAGEMENT IN INDIA

• The most commonly used tools of inventory management

in India are ABC analysis, FSN (fast moving, slow
moving, and nonmoving analysis), and inventory
turnover analysis.

• Inventory management in India can be improved by

effective computerisation, review of classifications,
improved coordination, development of long-term
relationships, and disposal of obsolete/surplus
inventories, and adoption of challenging norms.